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Eisen- und Hüttenwerke AG (FRA:EIS), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is EIS will have to follow strict debt obligations which will reduce its financial flexibility. While EIS has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
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Does EIS’s growth rate justify its decision for financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. The lack of debt on EIS’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if EIS is a high-growth company. A single-digit revenue growth of 2.1% for EIS is considerably low for a small-cap company. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Can EIS meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Eisen- und Hüttenwerke has no solvency issues, which is used to describe the company’s ability to meet its long-term obligations. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. With current liabilities at €23k, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1172x. Having said that, a ratio greater than 3x may be considered by some to be quite high, however this is not necessarily a negative for the company.
Next Steps:
EIS is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, its financial position may change. Keep in mind I haven’t considered other factors such as how EIS has been performing in the past. I recommend you continue to research Eisen- und Hüttenwerke to get a more holistic view of the stock by looking at: